Vanderbilt Law Review Volume 68 | Issue 6 Article 4 11-2015 Curb Your Enthusiasm for Pigovian Taxes Victor Fleischer Follow this and additional works at: https://scholarship.law.vanderbilt.edu/vlr Part of the Tax Law Commons Recommended Citation Victor Fleischer, Curb Your Enthusiasm for Pigovian Taxes, 68 Vanderbilt Law Review 1673 (2019) Available at: https://scholarship.law.vanderbilt.edu/vlr/vol68/iss6/4 This Article is brought to you for free and open access by Scholarship@Vanderbilt Law. It has been accepted for inclusion in Vanderbilt Law Review by an authorized editor of Scholarship@Vanderbilt Law. For more information, please contact [email protected]. ESSAYS Curb Your Enthusiasm for Pigovian Taxes Victor Fleischer* Pigovian(or "corrective") taxes have been proposed or enacted on dozens of harmful products and activities:carbon, gasoline, fat, sugar, guns, cigarettes, alcohol, traffic, zoning, executive pay, andfinancial transactions,among others. Academics of all politicalstripes are mystified by the public's inability to see the merits of using Pigovian taxes more frequently to address serious social harms, some even calling for the creation of a "Pigovianstate." This academic enthusiasm for Pigovian taxes should be tempered. A Pigovian tax is easy to design-as a uniform excise tax-if one assumes that each individual causes the same amount of harm with each incremental increase in activity on the margin. This assumption of uniform marginal social cost pairs well with the limited information and enforcement capacity of government institutions. But when marginal social cost varies significantly, a Pigovian tax may not lead to an optimal allocation of economic resources. Focusing on carbon emissions, where the assumption of uniform marginal social cost happens to be reasonable, obscures this common design flaw. Broadly speaking, Pigovian taxes are likely to be the optimal regulatory instrument only when (1) the harm is (or is properly analogized to) global pollution, and where the harm does not vary significantly based on the source, or (2) the variation in marginalsocial cost is easily observed and categorized, as with traffic congestion charges. This straightforwardinsight has broad implicationsfor how we design any targeted tax or subsidy. It explains why a carbon tax would work well, but * Professor of Law at the University of San Diego. I thank Jordan Barry, Jake Brooks, Dhammika Dharmapala, Miranda Fleischer, Jacob Goldin, Brian Galle, Michael Graetz, Michael Guttentag, Jim Hines, Lily Kahng, Louis Kaplow, Wojciech Kopczuk, Jim Leitzel, Gary Lucas, Jason Oh, Barak Orbach, Frank Partnoy, Eric Posner, Alex Raskolnikov, Tracey Roberts, David Schizer, Ted Sichelman, Kirk Stark, Eric Zolt, and participants at workshops at Columbia Law School, Loyola Law School (Los Angeles), UCLA, University of San Diego, University of Washington, the American Law & Economics Association, and the Midwestern Law & Economics Association for comments and suggestions on earlier versions of this Essay. 1673 1674 VANDERBILT LAW REVIEW [Vol. 68:6:1673 some other environmental taxes would not. It explains why many food taxes would be ineffective in improving public health. It explains why most sin taxes raise revenue but do not change behavior. Pigovian taxes are, under certain conditions, a useful instrument of regulatory policy, but we should resist the temptation of a Pigovian state. I. INTRODUCTION .............................. ..... 1674 II. THE WEAPON OF CHOICE FOR PHILOSOPHER KINGS......... 1682 A. Tax as an Alternative to Command-and-ControlRegulation ........ ..... 1682 B. Choice of Instrument ........................ 1687 III. TEN IMPLICATIONS FOR PIGOVIAN TAX DESIGN ..... .... 1690 A. The Assumption of Uniformity Holds For Global Pollution ......................... 1691 B. Use (Only) When Harm Can Be Estimated Ex Ante ..................... 1693 C. Place Discretion in the Agency with Specialized Expertise ........................ 1694 D. Beware Bimodal or Skewed Distributions............ 1697 E. Do Not Use if Elasticity CorrelatesInversely With Social Cost..... ....................... 1702 F. Get Used to Disappointment. .................. 1703 G. Food Taxes Are Likely to Fail................. 1704 H. Sin Taxes Modify Revenue, Not Behavior....... 1706 I. Consider Using When Variation is Easy to Observe ........................ 1708 J. Zero Is an Institutional Choice. ................ 1708 K. Pigovian Subsidies Aren't Any Better................... 1709 IV. CONCLUSION ............................... ...... 1710 V. APPENDIX....................................... 1711 I. INTRODUCTION Law professors have a tendency to act as if we are philosopher kings, descending into the cave to educate the prisoners.' We identify the ideal, and, embracing our role as guardian of the republic, we sketch out a plan to engineer the best social policy to reach that identified goal. In the twentieth century this tendency was most apparent in the form 1. See PLATO, THE REPUBLIC 214 (Benjamin Jowett trans., Barnes & Noble Books 1999) ("Mhey must be made to descend again among the prisoners in the den, and partake of their labours and honours, whether they are worth having or not."). 2015]1 PIGOVIAN TAXES 1675 of the command-and-control model of regulation, an approach that has fallen out of grace.2 For the newest generation of Platonic guardians, a Pigovian tax is a tempting gadget. 3 Corrective taxes are taxes that are designed primarily to change behavior rather than raise revenue. These taxes are often called "Pigovian" taxes in reference to Arthur Pigou, the British economist who pioneered the approach. 4 The idea is that by placing a small tax, equal to marginal social cost, on each unit of an activity to be discouraged-environmental pollution is the most common example- prices will rise, forcing polluters to internalize the social cost of the harmful activity. As a result, production will decrease, leading to an allocation of economic resources that reflects the true cost of the activity causing the pollution.6 Policy advocates have often inferred, erroneously,6 that using a Pigovian approach means that one need not know who is causing harm, where it is occurring, or how much it would cost each firm or individual to reduce the harmful activity. Indeed, if that were the case, one would only need an estimate of the total amount of an activity and the total social harm that results. While making such estimates would be challenging, it would be less challenging than the aggregate cost-benefit analysis required of many agency decisions under current law.7 These seemingly relaxed design specifications make Pigovian taxes a tempting instrument of social engineering, especially when compared to traditional command-and-control regulation.8 One finds considerable academic support for Pigovian taxes on a wide range of products and activities, including carbon, gasoline, fat, high fructose corn syrup, guns, financial transactions, executive pay, excessive zoning, and sport utility vehicles.9 Law professors and economists of all 2. See Rena I. Steinzor, Reinventing Environmental Regulation: The Dangerous Journey from Command to Self-Control 22 HARv. ENVTL. L. REV. 103, 103 (1998) (noting widespread acceptance of command-and-control critiques); Thomas H. Tietenberg, Economic Instruments for EnvironmentalRegulation, 6 OXFORD REV. ECON. POL'Y, Spring 1990, at 17, 17 (noting widespread recognition of the benefits of economic incentive regulation). 3. Jonathan S. Masur & Eric A. Posner, Toward a PigovianState 1 (Coase-Sandor Inst. for Law & Econ., Working Paper No. 716; Pub. Law & Legal Theory, Working Paper No. 503, 2015), http://ssrn.comlabstract=2559393[http://perma.cc/Q9DX-K34J] ("It is time for the regulatory state to take a Pigovian turn."). 4. See ARTHUR C. PIGOU, THE ECONOMICS OF WELFARE 172, 192-93 (4th ed. 1932) (describing situations where social costs and private costs diverge). 5. See JONATHAN GRUBER, PUBLIC FINANCE AND PUBLIC POLICY 134-35 (4th ed. 2013). 6. See infra text accompanying notes 25-26. 7. See Masur & Posner, supra note 3, at 1. 8. Quantity regulation, often referred to as "cap and trade," has many of the same institutional characteristics as a corrective tax. See infra text accompanying note 133. 9. See infra text accompanying notes 10-11, 24. 1676 VANDERBILT LAW REVIEW [Vol. 68:6:1673 political stripes, led by such luminaries as Louis Kaplow, Greg Mankiw, Gary Becker, and Robert Frank, are mystified by the public's inability to see the merits of using Pigovian taxes more frequently to address serious social harms.10 Most recently, Jonathan Masur and Eric Posner have issued a "Pigovian call to arms" on the grounds that not only do regulators have the legal authority to implement Pigovian taxes, they should replace any instance of command-and-control regulation with a tax." This academic exuberance for Pigovian taxes should be tempered. My goal is not to defend command-and-control regulation. Rather, I wish to highlight some often-overlooked weaknesses in the Pigovian instrument. In the circumstances where a Pigovian tax is not the right instrument, the right answer may be command-and-control regulation, or it may be some other approach, such as information disclosure, behavioral nudges, or ex post tort liability.12 Or it may be best to let sleeping dogs lie. I understand the temptation of a Pigovian state. Externalities are all around us. Your neighbor's lawnmower is too loud. You can smell the garbage from the restaurant